The International Swaps and Derivatives Association ruled yesterday that the Greek debt restructuring deal will trigger about $3 billion in credit default swaps, a tiny fraction of the total CDS insurance on the loans. This makes the debt swap a partial “credit event,” or default.

Billions of dollars are to be paid out in insurance-like instruments as Greece on Friday pressed ahead with the largest ever sovereign debt restructuring. In a test case for markets, the International Swaps and Derivatives Association, the derivatives trade body, announced there would be a pay-out, or credit event, for holders of credit default swaps.

It means there will be a net pay-out of about $3bn on CDS contracts, according to the data warehouse Depository Trust & Clearing Corp, in a boost for the relatively new market in sovereign debt protection that could also benefit eurozone debt markets amid worries that a failure to trigger could have undermined an important hedging instrument for holding government bonds. However, there was a long delay over the decision by the ISDA determinations committee, which is made up of 15 global banks and investment funds, that annoyed some investors. Uncertainty still hangs over the CDS market as an auction process to decide the amount of pay-outs may not take place for another week.

Bill Gross, who runs the world’s biggest private bond fund at Pimco, warned that CDS had been undermined by the saga. “The rules have been changed here,” he said in a radio interview. “The sanctity of their contracts is certainly lessened.”

But Robert Pickel, chief executive of ISDA, said: “I think the CDS market will come out well from this because we stayed to the letter of the contracts. The key thing was that a credit event could not be triggered until it was binding on all holders of the bonds. It would have been premature to trigger a credit event before now.”

I actually think the ISDA is correct in the sense that they held off on calling the situation a credit event until bondholders were told they would receive less on the dollar for their loans (through the collective action clause in their bond contracts), rather than agreeing to participate. In fact, under North American rules, Felix Salmon notes, restructuring wouldn’t have counted as a credit event at all.

Yet Bill Gross is right as well. The rules have changed. Only a portion of the CDS market got paid out. The ISDA never had to confront the default of a sovereign country like Greece before, and they did sort of make it up as they went along. They achieved their desired result in a stumbling manner. And Felix writes that this could end up fatal to the CDS market:

Going forwards, then, I can’t imagine that investors will have much if any confidence that CDS will really perform the hedging function they’re designed for. My feeling is that if you look at the numbers for total single-name CDS outstanding, they’ll decline steadily from here on in. Because you ultimately can’t trust them when you really need them.

I certainly hope so! Because CDS are completely dangerous. What’s more, as we saw with the AIG debacle, if the market fails, governments will come in and pay off the CDS at par, so they become just another part of the Too Big to Fail apparatus. Loosely regulated side markets that reach into the trillions of dollars might be good for the people who service the contracts and take a commission, but their value for the world is dubious.